----

----

**UNITED      STATES SECURITIES AND EXCHANGE COMMISSION **

**Washington,      D.C. 20549**

**FORM      10-Q**

**(Mark      One)**

|   |                                                                                                                                     |
|--------|------------------------------------------------------------------------------------------------------------------------------------------|
| þ | **QUARTERLY                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE                ACT OF                1934** |

**For      the quarterly period ended **
**March      31, 2008**

**or**

|   |                                                                                                                                      |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------|
| o      | **TRANSITION                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE                ACT OF                1934** |

**For      the transition period from **
**                    t**
**o      **
**                    **

**Commission      File Number: 000-32925**

**AVATAR      SYSTEMS, INC.**

**(Exact      Name of Registrant as Specified in its Charter)**

| **Texas**                                    |   | **75-2796037**                                                            |
|---------------------------------------------------|--------|---------------------------------------------------------------------------|
| **(State                of Incorporation)**  |   | **(I.R.S.                Employer Identification                Number)** |

**2801      Network Boulevard**

**Suite      210**

**Frisco,      Texas 75034**

**(Address      of Principal Executive Offices)**

**(972)      972-1800**

**(Registrant’s      Telephone Number, Including Area Code)**

**Indicate      by check mark whether the Registrant (1) has filed all reports required to      be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934      during the preceding 12 months (or for such shorter period that the      Registrant was required to file such reports), and (2) has been subject to      such filing requirements for the past 90 days.**

**Yes      **
**þ**
**      No **

**Indicate      by check mark whether the registrant is a large accelerated filer, an      accelerated filer, a non-accelerated filer, or a smaller reporting company.      See      the definitions of “large accelerated filer,” “accelerated filer’ and “smaller      reporting company” in Rule 12b-2 of the Exchange Act. **

**Large      accelerated filer **
**Accelerated      filer **

**Non-Accelerated      filer **
**Smaller      reporting company **
**þ**

**Indicate      by check mark whether the registrant is a shell company (as defined in      Rule 12b-2 of the Exchange Act).**

**Yes      **
**o**
**      No **

**Indicate      the number of shares outstanding of each of the issuer’s classes of common      stock, as of the latest practicable date.**

|                                         |   |                                           |
|----------------------------------------------|--------|------------------------------------------------|
| **Class**                               |   | **Outstanding                at May 14, 2008** |
|                                         |   |                                           |
| Common                Stock, $.001 par value |   | 9,038,152                                      |

----

----

| **PART                  I. FINANCIAL INFORMATION**                                                                                    | **1**  |
|---------------------------------------------------------------------------------------------------------------------------------------|--------|
| Item                  1. Financial Statements                                                                                         | 1      |
| Item                  2. Management’s Discussion and Analysis of Financial Condition and Results                  of Operations | 7      |
| Item                  4T. Controls and Procedures                                                                                     | 14     |
| **PART                  II. OTHER INFORMATION**                                                                                       | **14** |
| Item                  1. Legal Proceedings                                                                                            | 14     |
| Item                  2. Unregistered Sales of Equity Securities and Use of                  Proceeds                                 | 14     |
| Item                  3. Defaults Upon Senior Securities                                                                         | 14     |
| Item                  4. Submission of Matters to a Vote of Security Holders                                                          | 14     |
| Item                  5. Other Information                                                                                            | 14     |
| Item                  6. Exhibits                                                                                                     | 14     |
| Signatures                                                                                                                            | 15     |

----

**PART      I. FINANCIAL INFORMATION**

**Item      1. Financial Statements**

| Avatar                Systems, Inc.                                                           |   |
|-----------------------------------------------------------------------------------------------|--------|
| **BALANCE                SHEETS**                                                             |   |
|                                                                                          |   |   |   |   |   |
|                                                                                          |   | March                31, |   | December                31, |   |
|                                                                                          |   | 2008 |   | 2007 |   |
|                                                                                          |   | (unaudited) |   | (audited) |   |
| **ASSETS**                                                                                    |   |   |   |   |   |
| **CURRENT                ASSETS**                                                             |   |   |   |   |   |
| Cash                and cash equivalents                                                      |   | $ | 723,272 |   | $ | 706,772 |   |
| Marketable                securities                                                          |   |   | 362,043 |   |   | 376,853 |   |
| Accounts                receivable                                                            |   |   | 271,492 |   |   | 518,376 |   |
| Prepaid                expenses and other current assets                                      |   |   | 34,377 |   |   | 39,421 |   |
| **Total                current assets**                                                       |   |   | 1,391,184 |   |   | 1,641,422 |   |
|                                                                                          |   |   |   |   |   |   |   |
| **PROPERTY                AND EQUIPMENT**,                net of accumulated depreciation     |   |   |   |   |   |   |   |
| of                $740,883 and $695,626, respectively                                         |   |   | 322,516 |   |   | 330,925 |   |
| **PURCHASED                SOFTWARE,**net                of accumulated amortization          |   |   |   |   |   |   |   |
| of                $1,371,590 and $1,295,101, respectively                                     |   |   | 1,631,773 |   |   | 1,708,262 |   |
| **SOFTWARE                DEVELOPMENT COSTS,**                net of accumulated amortization |   |   |   |   |   |   |   |
| of                $2,335,235 and $2,236,256, respectively                                     |   |   | 3,380,527 |   |   | 3,273,894 |   |
|                                                                                          |   |   |   |   |   |   |   |
| **OTHER                ASSETS, net**                                                          |   |   | 104,248 |   |   | 116,486 |   |
| **Total                assets**                                                               |   | $ | 6,830,248 |   | $ | 7,070,989 |   |

| **LIABILITIES,                TEMPORARY EQUITY AND**                                                                 |   |   |      |   |   |
|----------------------------------------------------------------------------------------------------------------------|--------|--------|-----------|--------|--------|
| **PERMANENT                STOCKHOLDERS' EQUITY**                                                                    |   |   |      |   |   |
|                                                                                                                 |   |   |      |   |   |
| **CURRENT                LIABILITIES**                                                                               |   |   |      |   |   |
| Accounts                payable                                                                                      |   | $      | 279,365   |   | $      | 200,637 |   |
| Accrued                expenses                                                                                      |   |   | 187,070   |   |   | 203,101 |   |
| Line-of-credit                                                                                                       |   |   | -         |   |   | 145,067 |   |
| Federal                income taxes payable                                                                          |   |   | 66,752    |   |   | 162,385 |   |
| Current                maturities of capital lease obligations                                                       |   |   | 19,158    |   |   | 21,016 |   |
| Current                maturities of long-term debt                                                                  |   |   | 95,300    |   |   | 95,300 |   |
| Current                maturities of notes payable-stockholders                                                      |   |   | 116,727   |   |   | 113,174 |   |
| Deferred                revenue                                                                                      |   |   | 421,820   |   |   | 568,562 |   |
| Deferred                income taxes                                                                                 |   |   | 37        |   |   | 5,437 |   |
| **Total                current liabilities**                                                                         |   |   | 1,186,229 |   |   | 1,514,679 |   |
|                                                                                                                 |   |   |      |   |   |   |   |
| **DEFERRED                INCOME TAXES**                                                                             |   |   | 568,244   |   |   | 569,035 |   |
|                                                                                                                 |   |   |      |   |   |   |   |
| **OTHER                LONG-TERM LIABILITIES**                                                                       |   |   | 80,150    |   |   | 82,792 |   |
|                                                                                                                 |   |   |      |   |   |   |   |
| **LONG-TERM                DEBT**                                                                                    |   |   |      |   |   |   |   |
| Long-term                capital lease obligations                                                                   |   |   | 19,104    |   |   | 23,723 |   |
| Long-term                debt                                                                                        |   |   | 278,761   |   |   | 302,586 |   |
| Note                payable-stockholders                                                                             |   |   | 423,716   |   |   | 454,230 |   |
| Convertible                notes payable-stockholders                                                                |   |   | 280,000   |   |   | 280,000 |   |
| **Total                long-term debt**                                                                              |   |   | 1,001,581 |   |   | 1,060,539 |   |
| **Total                liabilities**                                                                                 |   |   | 2,836,204 |   |   | 3,227,045 |   |
|                                                                                                                 |   |   |      |   |   |   |   |
| **COMMITMENTS                AND CONTINGENCIES**                                                                     |   |   | -         |   |   | - |   |
|                                                                                                                 |   |   |      |   |   |   |   |
| **TEMPORARY                EQUITY**                                                                                  |   |   |      |   |   |   |   |
| Common                stock, subject to put rights, 200,000 shares issued and                outstanding             |   |   | 101,000   |   |   | 101,000 |   |
|                                                                                                                 |   |   |      |   |   |   |   |
| **PERMANENT                STOCKHOLDERS' EQUITY**                                                                    |   |   |      |   |   |   |   |
| ** **Preferred                stock, $0.001 par value, 10,000,000 shares authorized; none                issued |   |   | -         |   |   | - |   |
| Common                stock, $0.001 par value; 30,000,000 shares authorized;                                         |   |   |           |   |   |  |   |
| 8,838,152                shares issued and outstanding                                                               |   |   | 8,838     |   |   | 8,838 |   |
| Paid-in                capital                                                                                       |   |   | 2,245,930 |   |   | 2,238,684 |   |
| Retained                earnings                                                                                     |   |   | 1,638,204 |   |   | 1,484,868 |   |
| Accumulated                other comprehensive income                                                                |   |   | 72        |   |   | 10,554 |   |
| **Total                stockholders' equity**                                                                        |   |   | 3,893,044 |   |   | 3,742,944 |   |
| **Total                liabilities, temporary equity and permanent stockholders'                equity**             |   | $      | 6,830,248 |   | $      | 7,070,989 |   |
|                                                                                                                 |   |   |      |   |   |   |   |
| See                accompanying notes to financial statements.                                                       |   |   |      |   |   |   |   |

----

| Avatar                Systems, Inc.                                                        |
|--------------------------------------------------------------------------------------------|
| **STATEMENTS                OF OPERATIONS AND COMPREHENSIVE INCOME                (LOSS)** |

|                                                  |   |                              |      |        |   |
|-------------------------------------------------------|--------|-----------------------------------|-----------|-------------|--------|
|                                                  |   | Three                months ended |      |
|                                                  |   | March                31,          |      |
|                                                  |   | 2008                              |      | 2007        |   |
|                                                  |   | (unaudited)                       |      | (unaudited) |   |
|                                                  |   |                              |      |        |   |
| **Revenue:**                                          |   |                              |      |        |   |
| Software                                              |   | $                                 | 224,747   |        | $      | 143,751 |   |
| Maintenance                                           |   |                              | 755,578   |        |   | 626,294 |   |
| Professional                services                  |   |                              | 319,165   |        |   | 176,891 |   |
| Hardware                                              |   |                              | 6,475     |        |   | 19,312 |   |
| **Total                revenue**                      |   |                              | 1,305,965 |        |   | 966,248 |   |
|                                                  |   |                              |      |        |   |   |   |
| **Cost                of revenue:**                   |   |                              |      |        |   |   |   |
| Software                                              |   |                              | 66,345    |        |   | 60,050 |   |
| Maintenance                                           |   |                              | 186,550   |        |   | 117,599 |   |
| Professional                services                  |   |                              | 80,710    |        |   | 55,926 |   |
| Hardware                                              |   |                              | 5,790     |        |   | 16,928 |   |
| **Total                cost of revenue**              |   |                              | 339,395   |        |   | 250,503 |   |
|                                                  |   |                              |      |        |   |   |   |
| **Gross                profit**                       |   |                              | 966,570   |        |   | 715,745 |   |
|                                                  |   |                              |      |        |   |   |   |
| **Operating                expenses:**                |   |                              |      |        |   |   |   |
| Sales                and marketing                    |   |                              | 81,935    |        |   | 105,910 |   |
| General                and administrative             |   |                              | 398,117   |        |   | 310,539 |   |
| Amortization                                          |   |                              | 175,468   |        |   | 189,748 |   |
| Depreciation                                          |   |                              | 45,257    |        |   | 51,107 |   |
| **Total                operating expenses**           |   |                              | 700,777   |        |   | 657,304 |   |
|                                                  |   |                              |      |        |   |   |   |
| **Operating                income**                   |   |                              | 265,793   |        |   | 58,441 |   |
|                                                  |   |                              |      |        |   |   |   |
| **Other                income (expense):**            |   |                              |      |        |   |   |   |
| Investment                income                      |   |                              | 7,576     |        |   | 4,232 |   |
| Loss                on sales of marketable securities |   |                              | -         |        |   | (15 | ) |
| Interest                expense                       |   |                              | (54,072   | )           |   | (71,618 | ) |
| **Total                other expense**                |   |                              | (46,496   | )           |   | (67,401 | ) |
|                                                  |   |                              |      |        |   |   |   |
| **Income                before income taxes**         |   |                              | 219,297   |        |   | (8,960 | ) |
|                                                  |   |                              |      |        |   |   |   |
| Income                tax expense (benefit)           |   |                              | 65,961    |        |   | (3,046 | ) |
|                                                  |   |                              |      |        |   |   |   |
| **NET                INCOME (LOSS)**                  |   | $                                 | 153,336   |        | $      | (5,914 | ) |

| **Other                comprehensive income (loss), net of tax:** |   |   |      |   |   |
|-------------------------------------------------------------------|--------|--------|-----------|--------|--------|
| Unrealized                gain (loss) on marketable securities    |   |   | (15,882   | )      |   | 524 |   |
| Income                tax expense (benefit)                       |   |   | (5,400    | )      |   | 178 |   |
| **Other                comprehensive income (loss)**              |   |   | (10,482   | )      |   | 346 |   |
|                                                              |   |   |      |   |   |   |   |
| **Total                comprehensive income (loss)**              |   | $      | 142,854   |   | $      | (5,568 | ) |
|                                                              |   |   |      |   |   |   |   |
| **Net                income (loss) per share:**                   |   |   |      |   |   |   |   |
| **Basic                and diluted**                              |   | $      | 0.02      |   | $      | - |   |
|                                                              |   |   |      |   |   |   |   |
| **Weighted                average common shares outstanding:**    |   |   |      |   |   |   |   |
| **Basic**                                                         |   |   | 9,038,152 |   |   | 9,038,152 |   |
| **Diluted**                                                       |   |   | 9,119,970 |   |   | 9,038,152 |   |
|                                                              |   |   |      |   |   |   |   |
| See                accompanying notes to financial statements.    |   |   |      |   |   |   |   |
|                                                              |   |   |      |   |   |   |   |

----

| Avatar                Systems, Inc.         |
|---------------------------------------------|
| **STATEMENTS                OF CASH FLOWS** |

|                                                                  |   |                              |     |        |   |
|-----------------------------------------------------------------------|--------|-----------------------------------|----------|-------------|--------|
|                                                                  |   | Three                months ended |     |
|                                                                  |   | March                31,          |     |
|                                                                  |   | 2008                              |     | 2007        |   |
|                                                                  |   | (unaudited)                       |     | (unaudited) |   |
| **Cash                flows from operating activities**               |   |                              |     |        |   |
| Net                income (loss)                                      |   | $                                 | 153,336  |        | $      | (5,914 | ) |
| Adjustments                to reconcile net income (loss) to net cash |   |                              |     |        |   |   |   |
| provided                by operating activities:                      |   |                              |     |        |   |   |   |
| Amortization                of software costs                         |   |                              | 175,468  |        |   | 189,748 |   |
| Non-cash                interest expense                              |   |                              | 26,452   |        |   | 33,230 |   |
| Depreciation                                                          |   |                              | 45,257   |        |   | 51,107 |   |
| Loss                on sale of marketable securities                  |   |                              | -        |        |   | 15 |   |
| Stock                compensation expense                             |   |                              | 7,246    |        |   | 3,764 |   |
| Deferred                income tax expense                            |   |                              | (791     | )           |   | (3,046 | ) |
| Changes                in operating assets and liabilities:           |   |                              |     |        |   |   |   |
| Accounts                receivable                                    |   |                              | 246,884  |        |   | 118,121 |   |
| Prepaid                expenses and other current assets              |   |                              | 5,044    |        |   | 2,182 |   |
| Accounts                payable                                       |   |                              | 78,728   |        |   | (65,579 | ) |
| Accrued                expenses                                       |   |                              | (16,031  | )           |   | (30,760 | ) |
| Federal                income taxes payable                           |   |                              | (95,633  | )           |   | - |   |
| Deferred                revenue                                       |   |                              | (146,742 | )           |   | (14,124 | ) |
| Other                long-term liabilities                            |   |                              | (2,642   | )           |   | (2,642 | ) |
| Net                cash provided by operating activities              |   |                              | 476,576  |        |   | 276,102 |   |
|                                                                  |   |                              |     |        |   |   |   |
| **Cash                flows from investing activities**               |   |                              |     |        |   |   |   |
| Software                development costs capitalized                 |   |                              | (205,612 | )           |   | (243,037 | ) |
| Purchases                of property and equipment                    |   |                              | (36,848  | )           |   | (15,930 | ) |
| Purchases                of marketable securities                     |   |                              | (1,072   | )           |   | (501,048 | ) |
| Proceeds                from sale of marketable securities            |   |                              | -        |        |   | 525,000 |   |
| Net                cash used in investing activities                  |   |                              | (243,532 | )           |   | (235,015 | ) |
|                                                                  |   |                              |     |        |   |   |   |
| **Cash                flows from financing activities**               |   |                              |     |        |   |   |   |
| Principal                payments on line-of-credit                   |   |                              | (145,067 | )           |   | - |   |
| Principal                payments on capital lease obligations        |   |                              | (6,477   | )           |   | (13,643 | ) |
| Principal                payments on long-term debt                   |   |                              | (23,825  | )           |   | (39,792 | ) |
| Principal                payments on note payable-stockholders        |   |                              | (41,175  | )           |   | (27,450 | ) |
| Net                cash used in financing activities                  |   |                              | (216,544 | )           |   | (80,885 | ) |
|                                                                  |   |                              |     |        |   |   |   |
| Net                increase (decrease) in cash and cash equivalents   |   |                              | 16,500   |        |   | (39,798 | ) |
|                                                                  |   |                              |     |        |   |   |   |
| Cash                and cash equivalents at beginning of quarter      |   |                              | 706,772  |        |   | 322,047 |   |
|                                                                  |   |                              |     |        |   |   |   |
| Cash                and cash equivalents at end of quarter            |   | $                                 | 723,272  |        | $      | 282,249 |   |
|                                                                  |   |                              |     |        |   |   |   |

| Supplemental                disclosure of cash paid for:                                            |   |   |    |   |   |
|-----------------------------------------------------------------------------------------------------|--------|--------|---------|--------|--------|
| Income                tax                                                                           |   | $      | 162,385 |   | $      | - |   |
| Interest                                                                                            |   | $      | 27,620  |   | $      | 37,809 |   |
|                                                                                                |   |   |    |   |   |   |   |
| Supplemental                disclosure of noncash investing and financing activities:               |   |   |    |   |   |   |   |
| Change                in unrealized gain (loss) on marketable securities, net of                tax |   | $      | (10,482 | )      | $      | 346 |   |
|                                                                                                |   |   |    |   |   |   |   |

----

**1.      Basis of Presentation**

**2.      Recent Accounting Standards and Pronouncements**

*Fair      Value Measurements*

*The      Fair Value Option for Financial Assets and Financial Liabilities Including      an      Amendment of FASB Statement No. 115 *
* *

*Share-Based      Payment*

*Business      Combinations *
*Non-controlling      Interests in Consolidated Financial Statements, an amendment of ARB No.      51*

----

**3.      Long-term Debt**

**Long-term      Debt to Financial Institution**

**Note      Payable-Stockholders**

----

**Convertible      Notes Payable-Stockholders**

**4.      Temporary Equity**

*Determination      of the Measurement Date for the Market Price of Acquirer Securities Issued      in a      Purchase Business Combination*
*Classification      and Measurement of Redeemable Securities.*

----

**5.      Stock Option Plans**

|                                                                 |   | March                31, |    |
|----------------------------------------------------------------------|--------|--------------------------|---------|
|                                                                 |   | 2008                     |    | 2007 |   |
| Operating                expenses:                                   |   |                     |    |   |   |
| General                and administrative (employee related options) |   | $                        | 7,246   |   | $ | 3,764 |   |
| Other                income (expense):                               |   |                     |    |   |   |   |   |
| Interest                expense                                      |   |                     | 25,891  |   |   | 32,364 |   |
| Share-based                expense before taxes                      |   |                     | 33,137  |   |   | 36,128 |   |
| Related                income tax benefits                           |   |                     | (11,266 | ) |   | (12,284 | ) |
| Share-based                expense, net of taxes                     |   | $                        | 21,871  |   | $ | 23,844 |   |

**Stock      Option Activity **

|                                                    |   | Options |      | Weighted                Average Exercise Price |   | Weighted                Average Remaining Contractual Term (years) |   | Aggregate                Intrinsic Value |   |
|---------------------------------------------------------|--------|---------|-----------|------------------------------------------------|--------|--------------------------------------------------------------------|--------|------------------------------------------|--------|
|                                                    |   |    |      |                                           |   |                                                               |   |                                     |   |
| Options                outstanding at December 31, 2007 |   |    | 1,258,477 |                                           | $      | 0.528                                                              |   |                                     |   |   |   |   |   |
| Options                granted                          |   |    | -         |                                           |   | -                                                                  |   |                                     |   |   |   |   |   |
| Options                exercised                        |   |    | -         |                                           |   | -                                                                  |   |                                     |   |   |   |   |   |
| Options                forfeited                        |   |    | (16,000   | )                                              | $      | 0.505                                                              |   |                                     |   |   |   |   |   |
| Options                outstanding at March 31, 2008    |   |    | 1,242,477 |                                           | $      | 0.529                                                              |   |                                     | 5.78   |   | $ | 66,165 |   |
| Options                exercisable at March 31, 2008    |   |    | 1,174,810 |                                           | $      | 0.530                                                              |   |                                     | 5.63   |   | $ | 62,443 |   |

**Item      2. **
**Management’s      Discussion and Analysis of Financial Condition and Results of      Operations**

----

**SPECIAL      NOTE REGARDING FORWARD-LOOKING STATEMENTS**

----

**Three      Months Ended March 31, 2008 Compared to Three Months Ended March 31,      2007**

*Revenue:*

|                                 |   | March                31, |      | Change |   |
|--------------------------------------|--------|--------------------------|-----------|--------|--------|
|                                 |   | 2008                     |      | 2007   |   | Amount% |   |   |   |
|                                 |   |                     |      |   |   |   |   |   |   |
| Software                             |   | $                        | 224,747   |   | $      | 143,751 |   | $ | 80,996 |   |   | 56.3 |   |
| Maintenance                          |   |                     | 755,578   |   |   | 626,294 |   |   | 129,284 |   |   | 20.6 |   |
| Professional                services |   |                     | 319,165   |   |   | 176,891 |   |   | 142,274 |   |   | 80.4 |   |
| Hardware                             |   |                     | 6,475     |   |   | 19,312 |   |   | (12,837 | ) |   | (66.5 | ) |
| Total                revenue         |   | $                        | 1,305,965 |   | $      | 966,248 |   | $ | 339,717 |   |   | 35.2 |   |

*Software:*

| ·   | Revenue                from software sales for the quarter ended March 31, 2008 increased                56.3%                to $224,747 compared with $143,751 from the quarter ended March 31,                2007. |
|--------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | The                increase in software sales was primarily due to increases in sales                of                Integra, iSynergy, and Petroware products of $30,147, $26,250 and                $18,000,                respectively. |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

*Maintenance:*

| ·   | Maintenance                revenue for the quarter ended March 31, 2008 increased 20.6% to $755,578                compared with $626,294 in 2007. |
|--------------------|----------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | Maintenance                revenue was impacted primarily by increases in Petroware ASP and                the                Integra products of $55,772 and $48,609, respectively, and by increases                of                $13,546 and $10,853 for AS400 maintenance and AS400 ASP,                respectively. |
|--------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | The                increase in maintenance revenue primarily related to Petroware ASP                and                Integra sales during the first quarter of 2007 and an increase in                maintenance prices at the beginning of the third quarter of                2007. |
|--------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

*Professional      services:*

| ·   | Professional                service revenue for the quarter ended March 31, 2008 increased 80.4%                to                $319,165 compared with $176,891 for the quarter ended March 31,                2007. |
|--------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | The                increase in professional services revenue of $142,274 included $87,710                for                website design, data conversion and custom programming related to                a large                sale made to a customer during the fourth quarter of                2007. |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | The                increase in professional services of $142,274 also included $15,898                in                custom programming, $16,275 related to iSynergy implementation services,                and $13,945 for training. |
|--------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

*Hardware:*

| ·   | Hardware                sales for the quarter ended March 31, 2008 decreased $12,837 to $6,475                from $19,312 for the quarter ended March 31, 2007. Hardware sales                for the                quarters ended March 31, 2008 and 2007 were insignificant. The third                and                fourth quarters of our fiscal year are usually when hardware sales                are                highest. Hardware sales can be very large in relation to overall                sales of                the Company and can impact our net income positively, but the Company’s                profitability is not dependent on hardware                sales. |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

----

*Cost      of Revenue:*

|                                 |   | March                31, |    | Change |   |
|--------------------------------------|--------|--------------------------|---------|--------|--------|
|                                 |   | 2008                     |    | 2007   |   | Amount% |   |   |   |
|                                 |   |                     |    |   |   |   |   |   |   |
| Software                             |   | $                        | 66,345  |   | $      | 60,050 |   | $ | 6,295 |   |   | 10.5 |   |
| Maintenance                          |   |                     | 186,550 |   |   | 117,599 |   |   | 68,951 |   |   | 58.6 |   |
| Professional                services |   |                     | 80,710  |   |   | 55,926 |   |   | 24,784 |   |   | 44.3 |   |
| Hardware                             |   |                     | 5,790   |   |   | 16,928 |   |   | (11,138 | ) |   | (65.8 | ) |
| Total                cost of revenue |   | $                        | 339,395 |   | $      | 250,503 |   | $ | 88,892 |   |   | 35.5 |   |

*Software:*

| ·   | Cost                of software sales for the quarter ended March 31, 2008 increased                10.5% to                $66,345 compared with $60,050 for the quarter ended March 31,                2007. |
|--------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | Cost                of software as a percentage of the related revenue decreased to 29.5%                for                the quarter ended March 31, 2008 from 41.8% in                2007. |
|--------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | Cost                of software sales increased $44,636 as a result of the iSynergy sales                (which is purchased from a vendor) during the first quarter of 2008.                The                increase was offset by lower commission costs of $41,038. Commission                costs                were higher during the first quarter of 2007 because of strong Petroware                ASP and Integra sales. Commission costs related to ASP sales have                been                reclassified to cost of                maintenance. |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

*Maintenance:*

| ·   | Cost                of maintenance revenue for the quarter ended March 31, 2008 increased                58.6% to $186,550 compared with $117,599 in                2007. |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | Cost                of maintenance as a percentage of the related revenue increased to                24.7%                for the quarter ended March 31, 2008 compared with 18.8% in                2007. |
|--------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | The                increase in cost of maintenance revenue of $68,951 included $23,090                in                commission costs related to ASP sales that was included in cost of                software in prior periods and an increase in salaries allocated to                cost of                maintenance of $41,891. |
|--------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

*Professional      services:*

| ·   | Cost                of professional services for the quarter ended March 31, 2008 increased                44.3% to $80,710 compared with $55,926 in                2007. |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | Cost                of professional services as a percentage of the related revenue decreased                to 25.3% for the quarter ended March 31, 2008 compared with 31.6%                in                2007. |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | The                increase of $24,784 in cost of professional services was due to commission                costs of $26,819 and $14,135 paid to a consulting firm for website                development. These additional costs were offset by lower salaries                allocated to cost of professional services of                $16,597. |
|--------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

*Hardware:*

| ·   | Cost                of hardware sales for the quarter ended March 31, 2008 decreased                to $5,790                compared with $16,928 in 2007. Cost of hardware sales was directly                related                to the decrease in hardware sales. |
|--------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

----

*Operating      Expenses:*

|                                      |   | March                31, |    | Change |   |
|-------------------------------------------|--------|--------------------------|---------|--------|--------|
|                                      |   | 2008                     |    | 2007   |   | Amount% |   |   |   |
|                                      |   |                     |    |   |   |   |   |   |   |
| Sales                and marketing        |   | $                        | 81,935  |   | $      | 105,910 |   | $ | (23,975 | ) |   | (22.6 | ) |
| General                and administrative |   |                     | 398,117 |   |   | 310,539 |   |   | 87,578 |   |   | 28.2 |   |
| Amortization                              |   |                     | 175,468 |   |   | 189,748 |   |   | (14,280 | ) |   | (7.5 | ) |
| Depreciation                              |   |                     | 45,257  |   |   | 51,107 |   |   | (5,850 | ) |   | (11.4 | ) |
| Total                operating expenses   |   | $                        | 700,777 |   | $      | 657,304 |   | $ | 43,473 |   |   | 6.6 |   |

*Sales      and Marketing:*

| ·   | Sales                and marketing expenses for the quarter ended March 31, 2008 decreased                22.6% to $81,935 compared with $105,910 in                2007. |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | Sales                and marketing expenses as a percentage of total revenues decreased                to 6.3%                for the quarter ended March 31, 2008 compared with 11.0% for                2007. |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | The                decrease in sales and marketing for the quarter ended March 31, 2008                is                due to efficiencies that have been created by the consolidation of                our                marketing efforts subsequent to our acquisition of                Questa. |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

*General      and administrative:*

| ·   | General                and administrative expenses for the quarter ended March 31, 2008                increased                28.2% to $398,117 compared with $310,539 in 2007. |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | General                and administrative expenses as a percentage of total revenue decreased                to                30.5% for the quarter ended March 31, 2008, compared with 32.1% in                2007.                The decrease in the percentage of general and administrative expenses                as a                percentage of total revenue is related to higher overall total                revenue. |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | The                increase in general and administrative expense of $87,578 was due                to an                increase in salaries of $44,545 and an increase of $41,960 due to                recognition of annual auditing costs during the quarter ended March                31,                2008. Annual auditing costs for the year ended December 31, 2006                were                recognized during the second quarter of 2007 when the audit was                completed. |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

*Amortization:*

| ·   | Amortization                expense decreased 7.5% to $175,468 for the quarter ended March 31,                2008                from $189,748 in 2007. |
|--------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | Amortization                expense as a percentage of total revenue decreased to 13.4% for the                quarter ended March 31, 2008 compared with 19.6% in 2007. The decrease                in                the percentage of amortization expense is attributable to higher                overall                revenues. |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

*Depreciation:*

| ·   | Depreciation                expense decreased 11.4% to $45,257 for the quarter ended March 31,                2008                from $51,107 in 2007. |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------|

| ·   | Depreciation                expense as a percentage of total revenue decreased to 3.5% for the                quarter                ended March 31, 2008 compared with 5.3% in 2007. The decrease in                the                percentage of depreciation expense is attributable to higher overall                revenues. |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

----

*Other      Income (Expense):*

|                                                  |   | March                31, |    | Change |   |
|-------------------------------------------------------|--------|--------------------------|---------|--------|--------|
|                                                  |   | 2008                     |    | 2007   |   | Amount% |   |   |   |
|                                                  |   |                     |    |   |   |   |   |   |   |
| Investment                income                      |   | $                        | 7,576   |   | $      | 4,232 |   | $ | 3,344 |   |   | 79.0 |   |
| Loss                on sales of marketable securities |   |                     | -       |   |   | (15 | ) |   | 15 |   |   | (100.0 | ) |
| Interest                expense                       |   |                     | (54,072 | )      |   | (71,618 | ) |   | 17,546 |   |   | (24.5 | ) |
| Total                other expense                    |   | $                        | (46,496 | )      | $      | (67,401 | ) | $ | 20,905 |   |   | (31.0 | ) |

*Investment      Income:*

| ·   | Investment                income increased to $7,576 for the quarter ended March 31, 2008 from                $4,232 because of higher invested balances during the                quarter. |
|--------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

*Interest      Expense:*

|                                                  |   | Stated                     |   |         |   | Financing    |   | Total    |   |
|-------------------------------------------------------|--------|----------------------------|--------|--------------|--------|--------------|--------|----------|--------|
|                                                  |   | Interest                on |   | Discount     |   | Cost         |   | Interest |   |
|                                                  |   | Notes                      |   | Amortization |   | Amortization |   | Expense  |   |
|                                                  |   |                       |   |         |   |         |   |     |   |
| Line                of credit                         |   | $                          | 116    |         | $      | -            |   | $        | -      |   | $ | 116 |   |
| Capital                lease obligations              |   |                       | 1,546  |         |   | -            |   |     | -      |   |   | 1,546 |   |
| Long-term                promissory notes             |   |                       | 8,304  |         |   | -            |   |     | 11,677 |   |   | 19,981 |   |
| Notes                payable-stockholders             |   |                       | 14,823 |         |   | 14,214       |   |     | -      |   |   | 29,037 |   |
| Convertible                notes payable-stockholders |   |                       | 2,831  |         |   | -            |   |     | -      |   |   | 2,831 |   |
| Other                                                 |   |                       | 561    |         |   | -            |   |     | -      |   |   | 561 |   |
| Total                interest expense                 |   | $                          | 28,181 |         | $      | 14,214       |   | $        | 11,677 |   | $ | 54,072 |   |

|                                                  |   | Stated                     |   |         |   | Financing    |   | Total    |   |
|-------------------------------------------------------|--------|----------------------------|--------|--------------|--------|--------------|--------|----------|--------|
|                                                  |   | Interest                on |   | Discount     |   | Cost         |   | Interest |   |
|                                                  |   | Notes                      |   | Amortization |   | Amortization |   | Expense  |   |
|                                                  |   |                       |   |         |   |         |   |     |   |
| Line                of credit                         |   | $                          | 3,264  |         | $      | -            |   | $        | -      |   | $ | 3,264 |   |
| Capital                lease obligations              |   |                       | 2,093  |         |   | -            |   |     | -      |   |   | 2,093 |   |
| Long-term                promissory notes             |   |                       | 10,686 |         |   | -            |   |     | 14,596 |   |   | 25,282 |   |
| Notes                payable-stockholders             |   |                       | 18,426 |         |   | 17,768       |   |     | -      |   |   | 36,194 |   |
| Convertible                notes payable-stockholders |   |                       | 2,800  |         |   | -            |   |     | -      |   |   | 2,800 |   |
| Other                                                 |   |                       | 1,985  |         |   | -            |   |     | -      |   |   | 1,985 |   |
| Total                interest expense                 |   | $                          | 39,254 |         | $      | 17,768       |   | $        | 14,596 |   | $ | 71,618 |   |

*Provision      for Income Taxes:*

----

*Liquidity      and Capital Resources*

*Cash*
*      flows from Operating Activities:*

*Cash      Flows from Investing Activities:*

*Cash*
*      Flows from Financing Activities:*

*Working*
*      Capital:*

----

**Item      4T. Controls and Procedures**

**PART      II. OTHER INFORMATION**

**Item      1.****Legal Proceedings**

**Item****2.**** ****Unregistered      Sales of Equity Securities and Use of Proceeds**

**Item      3. Defaults Upon Senior      Securities**

**Item      4. Submission of Matters to a Vote of Security Holders**

**Item      5.**
**      Other Information**

**Item      6. Exhibits**

**a.      Exhibits**

| Exhibit                No. |   | Description                of Exhibits                                   |
|----------------------------|--------|--------------------------------------------------------------------------|
| 31.1                       |   | Section                302 Certification pursuant to Sarbanes-Oxley Act. |
| 32.1                       |   | Section                906 Certification pursuant to Sarbanes-Oxley Act  |
| 10.1                       |   | Amendment                to Loan and Security Agreement                  |
| 10.2                       |   | Amendment                to Loan and Security Agreement                  |

----

**S**
**ignatures**

|                                             |                                                                                                         |                                                |
|--------------------------------------------------|--------------------------------------------------------------------------------------------------------------|-----------------------------------------------------|
|  **Dated:              May 20, 2008**  | AVATAR                SYSTEMS, INC.                                                                          |
|                                        |                                                                                                    |                                           |
|                                             | By:                                                                                                | /s/ ROBERT              C.              SHREVE |
|                                             | Robert                C. Shreve Chief                Executive OfficerChief                Financial Officer |
|                                             |                                                                                                         |

----